♪ eeper into still another recession people despair and ask "why is the economy so unstable?" the business cycle proves capitalism has failed, according to karl marx but joseph schumpeter sees these cycles as proof of the glorious success of capitalism. is either man right? 1929 is the year of collision between 19th-century economic theory and 20th-century economic reality. out of the crash john maynard keynes provides a new theory of the business cycle. what was his revolutionary idea? boom and bust: who can explain the business cycle? with the help of richard gill,
factories sit idle or stagger along because nobody has any money to spend. workers sit home without any money to spend hoping the economy gets better so they can work again. it's a pattern that repeats itself over and over again. few people worried about trying to explain economic fluctuations during the 19th century. americans were too busy building railroads expanding commerce overseas, or creating new industry. the years after the civil war saw a continuing expansion of the american economy. although this prosperity was interrupted by periodic slumps few people seemed to worry. didn't the economy always bounce back? on the eve of world war i, economists had no theory to explain recurring downturns. why not?
we asked some economic historians. the bubbles, the panics, the convulsions, revulsions, crises, gluts, they were noticed back in the 1810s, but the idea of a cycle-- good times and then bad times-- took a long time until it reached the level of the professionalists. they were just beginning to be professional economists. it took a longer time until people began thinking there was a mechanism that turned one into the other. i think the economy was just more resilient in the 19th century. a lot of thought didn't go to explaining a problem when they didn't see a problem. wages would adjust much more quickly in the 19th century than in the 20th century. interest rates would adjust, so no sense creating a tool for a problem
that to them wasn't there. economists believe that in bad times, when investments stopped when businessmen stopped putting up new plants, savings would keep piling up in the banks and they would look for markets. the competition among banks to get rid of their savings pushed down the interest rate. that was another reason why people thought it would be self-maintaining not only the dynamism of the system, but that this continuous flow of savings would push the interest rate down and that would induce businessmen to go back to investing. in the early 20th century, businessmen still clung to a theory called say's law which said when they produced a commodity they automatically created a demand. early in 1914, it was obvious that
something was wrong. unemployment was climbing, factories were closing. it was an old story. the slump had no apparent cause, at least none that was evident to the wilson administration. treasury secretary william mcadoo shrugged off the recession as "a propaganda of pessimism." republicans had no doubt why the economy faltered. it was that daerous democrat woodrow wilson. while many were quick to blame wilson, few thought the government should intervene to correct the situation. the prevailing point of view seemed to be that the business cycle was correcting an imbalance, and that by intervening, you might only make things worse. by the government coming in and purchasing more goods and services to take up for the lack of business investment
they might adversely affect the little business investment that there was. it's doubtful that this attitude provided much comfort to the unemployed workers who lined new york streets demanding assistance workers who had barely recovered from the panic of 1907. but when relief came it changed the world. when europe hurled itself into battle in august 1914 neutral americans began supplying food and weapons for the belligerents on both sides. the recession soon vanished as america cranked up to meet the new demand. looking back it seems uncertainty over events in europe caused the american economy to turn sour.
when uncertainty evaporated in the face of war the economy boomed once again. some radicals complained bitterly that war was the health of the state but on the whole americans welcomed prosperity. richard gill what did economists think then? they saw these fluctuations as temporary. there was a long tradition in classical western economics that there could be no such thing as general overproduction. depressions would cure themselves. when labor was unemployed, all labor had to do was accept lower wages. businesses would be happy to rehire them and prosperity would soon return. underlying this view was say's law, after the 19th-century economist j.b. say. what did say say? he said that, in total
supply always creates its own demand. there can never be long-lasting overproduction since each good is either demanded by ourselves or is used to demand some other good. in the early part of this century, a businessman might produce 2000 ladies' bonnets. what does he do with these bonnets? he gives one to his wife he exchanges the rest for other goods. he buys a stove, a car, candy. this is the big point. these added bonnets represent added demand for other goods-- stoves, cars, candy. demand is nothing more than one set of goods being offered in exchange for another. say admitted there could be temporary problems with this. there might be overproduction of a particular good.
also, money could be a problem. a collapse of confidence in the banking system could throw a monkey wrench into the works but only temporarily. there would always be a market for goods and labor. wages might have to come down. producers might have to shift from bonnets to stoves but everything works out for the best. the economy bounces right back so said j.b. say. for over a century most economists agreed. most, but not all. world war i. president wilson promised to keep america neutral. he couldn't keep his promise. america went to war in 1917, singing the yanks are coming. a year and a half later, the doughboys came home,
bloodied, weary, glad it was finally over over there. returning soldiers found neither peace nor prosperity. the war had been good for the labor movement-- employment high, wages good, and the government sympathetic to unions. with the armistice the economy slowed down. the demand for manpower shrank. support for unions virtually disappeared. american workers were angry. labor strikes turned violent. critics of the capitalist system were jailed, even deported. one man predicted this turmoil the economic instability the growing militancy of labor and the eventual destruction of the capitalist system. where earlier theorists worried over the businessman
karl marx seemed to speak to the worker. irving kaplan remembers the intoxication of the marxian theory. the idea that the worker the value of the product is the work put into it-- i had the feeling ever since that time-- is the key to the popularity of marxism in the working class. namely, i'm the big shot. i produce all these things. labor is raised to a level of the greatest dignity. preachers talked about the dignity of work, but this explained why i'm the source of all the value. the son of a bitch who lives so well is living at my expense. he's appropriated part of this value. as workers and businessmen continued to struggle
in the postwar years prices continued to rise. the bubble burst in june, 1920. within a year, prices had dropped by 50%, while unemployment, virtually nonexistent during the war jumped to 14% in 1921. among the 19th-century economic theorists only marx had an explanation. robert heilbroner explains. marx was the first economist really to conceive of a self-generated cycle in which good times produced eventual bad times, and the bad times produced good times. he had a theory of the business cycle, a very complicated theory, in which good times produced their own contradictions-- tensions is a good word-- which eventually brought the thing to a climax. the bad times, in turn produced their own healing properties.
businesses would go under, wages would go down, business would be for sale very cheap. the stage was set for a turnaround. marx had predicted these recurring cycles of boom and bust. as the economy of 1921 gasped marx's followers were quick to point out the failure of capitalism. were they right? not according to an economist who was forming his own theory. his name was joseph schumpeter. marx looked at the bust side and forecast destruction. schumpeter looked at the boom side and called it regeneration. schumpeter came and preached the belief that capitalisism was by its nature intrinsically dynamic. that was the essence of capitalism. to invent, innovate, to risk was the capitalist. he thought, just like in the feudal days
to get on a horse and fight was the very essence of what it was to be a knight. he deeply believed the real propulsion was provided by its faculty for continuously generating technological change of a both constructive and destructive kind. in comes a new invention and down goes three old businesses. he called it the gale of creative destruction. in january 1922, without the benefit of any government intervention the economy surged out of its doldrums and into the roaring twenties the big boom. the evidence of growth seemed to support schumpeter. industry prospered, helped along by such innovations as the assembly line. if workers weren't always prosperous, schumpeter would argue capitalists gave energy
to the system and the workers eventually benefited. marx and schumpeter, two economists looking at the system and seeing it differently. marx saw economic fluctuations as evidence of the failure of the system. schumpeter saw these same cycles as evidence of economic growth and the system's success. how could these two come to such different views? they did have very different views but they both agreed that crises were a built-in, not an accidental feature, of the capitalistic system. they both differed from the classical economists who held that depressions were temporary and uncharacteristic. writing in the mid-19th century marx was impressed by the horror stories of the english industrial revolution--
child labor, workers replaced by machines peasants dispossessed of their land. he saw business crises as increasing in intensity-- workers immiserized, labor thrown out of work by capitalists capitalists unable to find markets for their goods. schumpeter wrote 3/4 of a century later and was deeply impressed by phenomenal economic growth realized under capitalism. business cycles represented the digestive process of capitalism, absorbing the new flood of goods then bouncing back to produce more goods. laboring classes were the beneficiaries of capitalist mass production. i took a course from schumpeter on marxian economics. while he admired marx's analysis, he couldn't accept marx's theory of the exploitation of labor. schumpeter's own theory of the business cycle
was not fully convincing. on the eve of the great depression, most economists were locked into the classical world of say's law. this is the herbert hoover building in washington, d.c., headquarters for the commerce department and a monument to a man who was once considered to be the world's greatest humanitarian. after 1929, the name hoover was virtually a curse word used to signify a cold, uncaring government. hoover had the misfortune of presiding over the beginning of the world's worst depression, which lasted 13 years. how did it happen and why were we unprepared? looking back on the 1920s, our memories go first to the fads, the heroes, the loose morals of the lost generation.
there was a more serious side to life. that was the glorious flowering of the industrial revolution. it was presided over by a man who positively despised governing. "the business of america is business," declared calvin coolidge. the financial community agreed. with the clarity of hindsight we can see that the economy was fundamentally unsound. there was a huge gap between the richest and poorest americans. banks failed at the rate of two a day. 2 million workers were unemployed. agriculture was in a state of depression throughout the 1920s. those weaknesses weren't obvious at the time, except to the victims. from business' perspective the economy was booming. throughout the decade,
productivity and profits kept climbing as prices and wages remained relatively stationary. huge profits were reinvested. the stock market soared. fortunes were made overnight. rags-to-riches stories filled the papers. even high school students played the game, as economist paul samuelson recalls. my high school teacher and i my mathematics school high teacher, used to pore over the financial page. she was in favor of hup motors. i thought auburn motors was better. both of them went off the board completely in the end. literally the case the elevator boys would ask you, "what do you think is good? "is barney baruch buying? what about the big boys at national city bank?" the dominant economic voice belonged to andrew mellon,
the secretary of the treasury from 1921 to 1931. eveyone was convinced the smartest man in america was the secretary of commerce, herbert hoover. even the hardened cynics of the washington press corps were impressed by hoover. i had unstinted admiration for him. he would sit at the end of a long table, and reporters would sit on either side. we'd each ask a question. he'd look fixedly down-- he was shy-- and after the last man had asked his question he'd put his head up. he'd remember each question and answer it. he knew more about what was going on in america than any other american. we'd say "this is an incredible man." then, one day, the magic stopped working.
the business community tried to weather the storm. president hoover told the nation the slump was temporary, that prosperity was just around the corner. calming words couldn't reverse the decline. willard thorp was an early analyst of the business cycle. he recalls the mood. chaos was just around the corner in the minds of people like myself. even though i'd studied plenty of cycles in the past and they had always turned around this one had gotten to a stage where it either had to turn around awful fast or else too many people would be just completely hopeless.
in 1928, herbert hoover said we were on the threshold of abolishing poverty. four years later he complained his opponents were playing politics with human misery. was hoover the villain? well, i don't know that hoover was a villain. hoover was carrying on the existing point of view that had dominated the behavior of the government up until that time-- namely, that it wasn't the government's business. laissez faire was the way in which the economy should operate. the price system would make the necessary adjustments. if things were going well, people would make profits, and if they weren't, they wouldn't make profits and that would help in the adjusting process.
this was the state of mind. this was what economists were saying, and the government had behaved that way for a long, long, long time. as the 1920s faded and with them, the memories of prosperity the 1930s brought an awareness that there was a serious split between traditional economic theories and present economic realities. john maynard keynes was building a theory that dealt with total purchasing power-- aggregate demand-- and asking whether this was in balance with aggregate supply. his answers pointed to a path out of the depression. essentially what keynes is saying is that the way to get rid of a depression is to create a demand. and that's the heart of his theory,
and the difficulty is that the demand for some reason, has shrunk more than the supply of goods. while keynes groped for an explanation that fit the depression, treasury secretary andrew mellon clung to the view that things would improve. he viewed the crash as a form of darwinian selection, designed to sweep away the unfit. people were less confident of the social benefits of the disaster. in playgrounds children chanted "mellon pulled the whistle hoover rang the bell "wall street gave the signal, and the country went to hell." in 1922, the country enjoyed a miraculous almost overnight recovery from the recession. there were no miracles this time. in 1930, president hoover declared, "the corner has been turned."
in 1931, he said it again. still the economy plunged downward. someone asked john maynard keynes if he could think of anything similar to this depression. "yes, it was called the dark ages." what was so different about keynes' view of the economy? to realize what a revolutionary idea keynes had, we have to recall again the classical view which said supply creates its own demand. if consumers don't want to consume all their incomes they can lend their savings to businesses who will invest it. the idea is that if consumption goes down, investment demand will go up. if investment demand goes down, consumption demand will go up. in either case total demand remains high.
keynes said if you had a fall in investment spending, this might lead to a fall in consumption spending. total demand-- consumption demand plus investment demand-- might fall. it might be a multiplied fall once the process got started. let me stress this was a shocking idea. when demand falls, it may not repair itself a la says law. it may fall further. there may not be enough total demand to provide markets for the goods or the labor that produces them. the economics profession was coming to grips with the possibility of a serious depression. it was on the verge of a revolution, not of marx's proletariat, but of ideas. periodic instability seems to be the curse of our free-market system.
whether the downturn comes as a small dip or as a major crash, every fluctuation takes its toll in lost opportunity and personal hardship. these cycles are not the death throes of capitalism but the system does not automatically correct itself. business cycles are the result generally of shifts in aggregate demand or total spending. how we learn and apply this are the subjects of future editions of economics usa. i'm david schoumacher. captioning made possible by the annenberg/cpb project captioning performed by the national captioning institute, inc. captions copyright 1986 educational film center
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